October 2019

Looking back and looking ahead
After a mediocre third quarter for the Sustainable Dividends Value Fund, the last three months of the year will determine whether 2019 will be a very good or just an average year for our investors. So far, after nine months, the fund is up 11%. Political developments and the upcoming quarterly results will be key factors for the performance in the fourth quarter. Whoever can predict the outcome of the Brexit saga deserves a statue. After the recent change in Tory leadership new prime minister Boris Johnson presents itself as the 21st century equivalent of his admired predecessor Winston Churchill. It is still not unlikely that the deal agreed upon with the European Union won’t pass the British parliament, and we will see further delays in the exit of the United Kingdom from the EU. Corporates won’t be amused, to say the least, if we would see a continuation of the current deadlock. The latest purchasing managers index numbers show that not only the industry, but now also the UK services sector is expecting a decline in activities ahead of us. This will most certainly put the economy of the ‘Perfidious Albion’ into a recession, as the second quarter already provided us with negative numbers.

Italy quickly to recover from the crisis
The UK might get accompanied by Germany, as the biggest economy in Europe might also head for a recession. In Germany the industry has had troubles for quite a while now. And the services sector now seems to follow that direction. However, a positive note is coming from the continuously falling unemployment data and the very decent 3% growth in consumption. We will have to wait and see whether the growth in consumption and government expenses will be enough to compensate for the falling exports and industrial output. Not all is that bad on the European continent. Surprisingly perhaps to many analysts – and especially those from Italy – the political crisis between the two populist movements in Italy (Lega and M 5S or Moviment Cinque Stelle) did resolve itself very quickly. After Lega threw in the towel M 5S didn’t waste any time and made a deal with the left PD party. The new government, but with the same Giuseppe Conte as prime minister, immediately dealt with the 2020 budget. An important theme here is to counter tax evasion. Mind you, Brussels still needs to approve the budget plans. Noteworthy is that the other ‘Club Med’ countries (Portugal, Spain and Greece) are also doing remarkably well.

A new European Commision
Meanwhile in Brussels the new chairwomen of the European Commission is preparing herself to take over the helm of her processor Jean Claude Juncker. German Ursula von der Leyen already lost two of her candidate commissioners during the hearings in the European Parliament. The parliament is still cross about the fact that the European leaders didn’t choose form the ‘Spitzen’ candidates, as proposed by the parliament. As first vice chairmen Frans Timmermans is responsible for all policies dealing with climate change, this will most likely be one of the priorities of the new Commission. Brussels will also have the deal with the trade dispute with the US. The latest judgement from the World Trade Organisation (WTO) that EU support for airplane manufacturer Airbus did indeed harm its competitor Boeing, perfectly suits US president Trump. It is still uncertain whether the US will fully reclaim the amount of 7.5 billion US dollar by raising import duties or not. The European Union of course hopes to strike some kind of a deal. The continued pressure that Trump is putting on FED chairman Powell so far resulted in a decrease of interest rates by 25 basis points. Too little according to Trump. As we see more and more signs of the US economy cooling down, the arm wrestling with Powell is likely to continue. For now, it seems that by starting the trade disputes with China and the EU, Trump has scored an own goal, as tariffs have slowed down the US economy considerably. Positive for equity investors is that there is hardly an alternative to investing in stocks due to the very low interest rates on bonds and cash.

Performance of the Sustainable Dividends Value Fund
As stated before, the fund performed better in previous quarters. Compared to the MSCI Europe, that gained 2.6%, the 2.7% drop in the share price was a rather pale performance. But, as we all know, we’re investing in equities for the long run. Since the start of the fund early 2016 the return is a solid 31%. This is considerably higher than the 20% return from the MSCI Europe over the same period.

What worked and what didn’t work in the portfolio?
Within the fund we had two Dutch stocks that lost considerably in the third quarter. Both TKH (-16%) and Neways (-20%) lost on disappointing half year results. TKH mentioned start-up costs for a new factory that will produce cables for connecting wind parks at sea to the electricity grid. We should note that TKH was the best performing stock in the second quarter, when it added 32% to the share price. Neways suffered from one-off relocation costs and start-up costs for new products. One of the gainers in the fund was Vopak (+13%), as the company will invest the proceeds coming from selling its oil terminal in Amsterdam in fast growing markets in Asia and Latin-America. British educational software company RM plc (+13%) was up on good quarterly numbers. The shares gained on higher revenues and the promise of increasing dividends. We see the increase in dividends as a signal of confidence by the management of the company. Later in this newsletter you will read more about this company. The latest purchase in the fund is medical services provider Fresenius Medical Care. The German company is operating globally in providing the best dialysis solutions for kidney patients.

What does the fund look like?
By far the largest part of the fund’s assets are invested in companies of which we expect that they will grow profits and dividends in the coming years. The assets are invested in 22 different companies in seven European countries. By choosing stocks in 13 sectors we make sure there is enough diversification in the portfolio. We have a clear preference for sectors that generate stable cash flows. Some sectors were on purpose not chosen in the fund. Banks, for example, are suffering from the ever-increasing regulation of the sector and ultra-low interest rates. In general, this is not in their advantage. Pharmaceutical companies are very much depending on the development of new medications. This is hard to predict, making the future cash flows uncertain at best. And most stocks of technology companies seem to be very expensive at the moment. As a result, their dividend returns are often very low. Below you’ll find the five biggest holdings in the fund and their weights in the fund.

RM plc: All about improving education
Like every quarter we discuss one of the stocks in the Fund in our newsletter. British RM plc is a company that sells products and services to improve education in the UK and other English speaking countries. First of all it is about all stuff to be found in class rooms. However, there is much more than that. The company is involved in providing schools with digital learning methods and digital exams. RM has been active on its home market for many years already. However, more and more demand is coming from education in the English language outside the United Kingdom. This market is huge and growing rapidly. International sales have gone up by 20% on average over the last five years, and in 2018 the growth abroad was nothing less than 30%. Management does expect to show similar numbers by the end of the current year.

Education improves lives
We do have some additional selection criteria, that a company should adhere to before we decide to invest in its stock. One of those is the balance sheet. The financials of RM look healthy. The company has very little debt and there shouldn’t be any problem servicing the debt. RM has been paying its shareholders increasing dividends for many year. Over the last six years dividends have been increased by on average 15% per year. And management indicates they will continue to do so in the future. They own some 2% of all shares themselves, which means that the interests of management and shareholders are very well aligned. This should give some comfort to the other shareholders of the company. RM scores high on sustainability as proper education is by far the best way to ban poverty and improve the lives of both children and adults. The products and services of RM do make a significant contribution to reducing poverty.

Risks and valuation
This wouldn’t be a proper investment case without looking at the risks of an investment. In the case of RM we will mention the most important risks. First of all RM is in many cases depending on government budgets for education. If budgets are lowered due to lower tax revenues, both sales and profits of RM could be impacted. A hard Brexit and the consequent recession in the UK is therefore a risk for the company. A depreciation of the British pound would imply higher costs for materials and software that gets bought or developed outside the UK. However, it also means higher revenues in pounds for those products sold abroad. To determine the proper valuation of a company, we tend to look at recent transactions in the market, that involve comparable companies. Over the last few years acquisitions in the education space were done at 8 to 10 times the expected cash flow of the companies involved. Acquisitions of software companies were done at much higher multiples. The RM stock currently trades at about 8 times the expected cash flow for next year. Het expected dividend return is just over 3%. More information regarding RM can be found in the annual report via the link below:

Outlook Statement
With on average just 7% annual return over the past 3 years European stocks are very much lagging other regions like for example the US. The significant increase in profits for European companies over the last few years does not show in the share prices yet. If we look at popular valuation metrics like the Price/Earnings-ratio or the Dividend Yield, it appears that European equities have become cheaper over the last few years. Both in absolute terms, as well as compared to American equities. This should make European equities an interesting investment for the next few years.

New participants
We warmly welcome our new participants in the fund. More and more often we can share our story with interested investors, which means lots of nice conversations. If you happen to know people who might also be interested in our strategy, we would be glad to talk to them as well. Gaining trust by speaking with investors directly is most important for us. We sincerely appreciate your support on this journey to grow the Sustainable Dividends Value Fund. We have only just begun, and a long road full of interesting investment opportunities is ahead of us. More information on the fund can be found on www.sustainabledividends.com. Feel free to email (info@sustainabledividends.nl) or call (+31 20 244 36 54) with any questions you might have. The share price development can be found on the website or via Bloomberg (fund code SUSDVDV NA).

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